War in Ukraine aggravates inflation and economic slowdown in Brazil

The conflict between Russia and Ukraine exacerbates two problems that have affected the Brazilian economy since the middle of last year: inflation and the slowdown in activity.

Furthermore, it may have anticipated the devaluation of the real that was expected for the second half of this year due to the proximity of the electoral process.

According to economists interviewed by the sheeteven if the war is short-lived, it will leave marks that will be felt by consumers, investors and workers, such as the additional pressure on food and fuel prices and the postponement of investment and hiring decisions by companies.

This Thursday (24), the American currency rose 2.01%, closing the session at R$ 5.1040. The jump occurred one day after the US currency had reached its lowest value against the Brazilian real since the end of June (R$ 5.0030).

Historical experience shows that geopolitical shocks do not have a very long duration, but are very intense at first, says economist Armando Castelar, a researcher at FGV Ibre (Brazilian Institute of Economics of Fundação Getulio Vargas).

This triggers moves towards safer assets and may leave some more permanent impact on inflation and growth.

“Risk aversion is the dominant impact in the short term. The dollar appreciates against other currencies. The exchange rate, which had been moving in a good direction [no Brasil]turned”, he says.

Castelar says that uncertainty regarding the conflict tends to reduce, and the decisive discussion for the economy will once again be the issue of the pandemic.

After this first moment, some prices should fall again, but he recalls that the process of rising inflation is faster than the downward movement. Therefore, he believes that there is one more reason for the Central Bank to be pressured to raise the basic interest rate from the current 10.75% to at least 12.75% per year.

Luca Mercadante, economist at Rio Bravo, says that the main impact of the conflict for Brazil at the moment is related to the rise in commodity prices, such as oil and wheat.

On the one hand, this will put pressure on inflation. On the other hand, there may be some positive impact for exporters of these products, in their results and in their actions, for example.

The barrel of Brent oil, the world reference for this commodity, surpassed the mark of US$ 105 during the day, the highest value since 2014, but closed below US$ 100.

The rise in the prices of basic products is one of the factors that contributed to the fall of the dollar against the real at the beginning of the year. With the conflict, however, many investors are already seeking protection in lower risk assets, such as US bonds, says Mercadante, weakening the Brazilian currency.

“If this war scenario worsens, the perspective is that we will see a migration to safer assets, and the stock market should lose some strength.”

The Rio Bravo economist assesses that higher inflation should not lead the Brazilian Central Bank to raise interest rates above the 12.25% per annum expected by most analysts, but says that the rate may take longer to fall if the high prices become more persistent.

Another risk for the country, according to him, is a possible weakening of the global economy, depending, for example, on the impact of the war on trade flows. Additional pressure on inflation in developed economies could also lead to higher interest rates abroad.

Insper professor Eduardo Correia says that, even in the context of a limited and short-lived war, the conflict postpones the resumption of the global economy and complicates the inflation scenario for Brazil, two bad news for the reelection plans of the president of the Republic.

He cites, for example, the exchange rate issue, which could help ease the pressure on prices.

“I didn’t expect the dollar to be at R$ 5.00 until the end of the year, and this crisis precipitated the devaluation scenario, because everyone goes to the safest asset, which is the dollar”, he says.

“It may take even longer for the Brazilian economy to overcome these problems: recession with unemployment and inflation.”